How To Calculate Your Customer Acquisition Cost
Today, many web-based businesses use highly-targeted marketing strategies to track consumers, attract them, and turn them into returning customers. Customer acquisition cost (CAC) is an essential metric of such marketing campaigns and helps determine their success.
CAC is the total amount of money a company allocates to get a new customer. In simpler words, it is the cost of persuading a prospect into buying a product or service. By tracking the CAC metric, companies can measure the return on investment (ROI) of their marketing efforts to expand their clientele.
The US Small Business Administration suggests a general rule of thumb for companies earning less than $5 million annually to spend around 7% to 8% of the total revenue on their marketing campaigns. But how can you know if you’ve invested your money in the right place? CAC will help you determine that.
This article will dig deeper into what CAC is, how you can calculate it, and its importance for companies these days.
What Is Customer Acquisition Cost?
Customer acquisition cost determines how much a company should allocate for attracting new consumers and making them long-lasting customers.
With the popularity of advanced web analytics tools, companies are now adopting CAC to develop data-driven marketing strategies that give them better results. Of course, no company would want to throw their money off on ineffective campaigns that simply add to their monthly expenses.
Previously, companies used to design their advertising campaigns for a broader audience in hopes of attracting relevant customers. This method used to be quite time-consuming and costly.
However, modern marketing is now more targeted and combined with metrics like CAC. Such campaigns help marketers quickly target specific categories of consumers and determine how much money they’d have to spend on making each prospect convert.
So, whether you want to increase website traffic or enhance customer retention rate, measuring your campaign’s CAC helps you determine if you’re getting the right value from your investment.
What Is Factored Into the Cost of Customer Acquisition?
Customer acquisition is a lengthy process consisting of numerous marketing, advertising, and sales steps. While calculating your customer acquisition cost, consider the factors below:
Marketing Campaign Costs
Marketing campaigns generally include designing content and publishing it to the audience. In every step, some costs are incurred.
For instance, the amount you spend on creating content, hiring new talent to promote your content, or taking your team out for brunch is a creative cost.
Similarly, you’d also have to evaluate the production costs that occur in creating content, such as buying a camera to record a video. Lastly, you’d have to promote your content to the target audience through social media ads, newspapers, or TV commercials. These are publishing costs.
All of these costs are collectively known as marketing campaign costs.
Advertising cost is the total money you spend on your ad campaigns. In this digital world, almost all small and large companies now consider advertising through all means a great way to create demand for their products and attract new customers.
But of course, these ads must be accurately targeted to the relevant target audience to yield better results. Making sure that you have a solid eCommerce marketing strategy will help you improve those numbers.
To calculate if your ads are getting you a good return on investment, you can simply divide the revenue earned via ads by the total money spent on the marketing campaign.
A company’s sales team uses different technologies to perform various operations and execute its functions efficiently. For instance, an inventory management tool tracks the company’s total inventory and sales.
It also provides sales professionals with accurate inventory figures to better manage stocks, orders, and overall production.
Another tool could be a reporting tool that helps sales teams track their open deals. The costs of all such tools are included in the technical costs or sales expenses.
Sales Team, Marketing Team, and Acquisition Team Salaries
Highly-skilled employees who are experts in their fields are nothing less than an investment. Thus, keeping your sales, marketing, and acquisition team satisfied and happy with their salaries is essential. After all, you can’t simply issue pay cuts.
Instead, automated tools could be a better option here, which automate the workflow without requiring human intervention. They also enhance your company’s overall productivity and reduce money spent on salaries.
What Is the Formula for Customer Acquisition?
To calculate customer acquisition costs, you’d have to add up all the costs discussed earlier and divide the resulting amount by the number of customers you’ve acquired at the end of a specific period.
The typical customer acquisition cost formula is:
Customer Acquisition Cost = Total Sales & Marketing Expenses ÷ Number of Customers Acquired
Suppose an organization spent $5,000 on its marketing expenses a year and acquired 1,000 customers. Dividing $5,000 by 1,000 would give you a $5 CAC. This means the company spent $5 on acquiring each customer. Similarly, if the company succeeds in attracting 500 customers, its CAC would be $10, which is double the amount it spent earlier.
The customer acquisition cost formula seems pretty simple. However, you may find it hard to estimate total marketing and sales expenditures and the total staff salaries.
Here are some examples to understand how to calculate CAC accurately:
Example 1: A Software Company
A project management software company spends $20,000 on its marketing expenses in a year. At the end of the year, it found that around 1,500 new customers purchased the software or signed up for the service.
Now, if the company allocates an extra $60,000 for production costs for these newly-acquired customers, the CAC would be calculated as:
CAC = ($20,000 + $60,000) ÷ 1,500 = $53.33
Thus, the company spent around $53 on acquiring each customer.
Example 2: A Manufacturing Company
A construction company that sells building materials spends $15,000 on its marketing campaigns and $5,000 on sales. It succeeded in acquiring 500 new customers. The total CAC incurred in hiring one customer equals:
CAC = ($15,000 + $5,000) ÷ 500 = $40
How Does Customer Lifetime Value Influence Cost of Acquisition?
One business metric to consider when calculating customer acquisition cost is the customer’s lifetime value (LTV). It is the total revenue a company earns from every customer during the entire period they keep making purchases or using a product.
The total time a person remains a customer and their spending vary significantly among industries. So, there is no rule of thumb or standard criteria to measure customer lifetime value.
A company has to evaluate a few elements to calculate LTV, including:
- Average Purchase Value: This value is calculated by dividing the total revenue of your company in a specific period by the total purchases made in that duration.
- Average Purchase Frequency: This is determined by dividing the total purchases in a specific period by the total customers acquired who made purchases in that duration.
- Customer Value: It is the product of the average purchase value and the average purchase frequency.
- Average Customer Lifespan: It is calculated by evaluating the average of the total number of years a customer keeps purchasing your company’s product.
Finally, calculate the LTV by multiplying the average customer lifespan with the customer value. The resulting number is the estimate of how much revenue you can expect from every customer to generate for you over the entire “lifetime” of your business relationship.
Therefore, your company’s LTV to CAC ratio gives you a quick estimate of a customer’s value with respect to how much it costs to acquire them.
Companies must find the perfect balance for this ratio to make their financial investments worth their efforts. It is estimated that a company takes one year to cover the total customer acquisition costs. So, your LTV:CAC ratio must be 3:1, or your customer value should be three times the customer acquisition costs.
If the ratio is 1:1, the company is spending the same amount of money on acquiring the customers as the revenue being generated. On the other hand, if it is higher than 3:1, your sales team isn’t taking advantage of better opportunities to acquire new customers.
What Is the Average Customer Acquisition Cost Across Industries?
So, let’s answer the million-dollar question: “What CAC is considered the ideal?” Well, that usually depends on the industry you’re operating in, as the customer acquisition costs depend on several factors, such as:
- Sales cycle duration
- Company maturity
- Customer lifespan
- Purchase value
- Purchase frequency
With all of these things to factor into calculating CAC, it’s understandable that the numbers can vary heavily. However, a good conversion rate will fall somewhere between 2-5% on average. As you work on the numbers for your company in your industry, make sure you’re meeting that percentage range. If you’re not, you may need to re-evaluate your business plan and customer relationship management.
Why Is It Important to Understand Your Customer Acquisition Metrics?
Understanding customer acquisition metrics is crucial for every business to make the most out of its marketing campaigns and investments. Every company wants to generate more revenue, expand its clientele, acquire greater market share, and dominate the market.
To achieve all these goals, a company must understand and utilize customer acquisition metrics appropriately. Here is why it is essential:
Demonstrates Success of Marketing Efforts
At its core, the primary purpose of your marketing campaigns is acquiring new clients and retaining them in the long run. Customer acquisition metrics help you evaluate the areas of your marketing campaigns that generate the desired value for your investment as well as the ones that don’t.
Once you identify the dead zones, you can either find ways to improve them or simply withdraw your investments as a whole.
Refines Your Business Marketing Strategies
From creating content to publishing it to the general audience, a company has to develop several strategies for the flawless execution of every step. Of course, these steps come with specific costs.
When you know the customer lifetime value (average customer lifespan and value), you can easily adjust your marketing strategies to retain customers longer, which will hopefully lead them to purchase more. In addition, the LTV and CAC ratio will help you easily estimate whether your marketing strategies should target creating customer value or acquiring new ones.
Helps Develop Product Pricing Strategy
When a company knows the number of purchases an average customer makes in their lifetime, it can develop more targeted and effective product pricing strategies.
For instance, if more customers are inclined toward buying a $5 phone case, your sales and marketing team can make the most out of it by offering a deal or a discount on the product.
Or in other cases, they may price the phone case a little higher since it is already in demand and decrease the price of another less-popular product to increase its purchase.
Creates Reasonable Revenue Goals
Understanding the amount of revenue an average customer generates helps companies set their goals accordingly. As a result, they neither think too unpractical about their objectives nor set unrealistic expectations about revenue.
Meanwhile, it also helps them allocate the proper sales, marketing, and acquisition budgets, reducing costs and maximizing the outputs.
Therefore, CAC metrics give companies a better idea about their expected revenues at the end of a specific period — monthly, quarterly, annually, etc.
Improve Your Acquisition Process and Costs With a Growth Marketing Company
Companies can improve their customer acquisition cost and process in several ways. One way is to add value to your products.
For instance, collect customer feedback and see what they perceive or think about your product. Whether adding a new feature or fixing a product, giving people what they need is the best way to make them your loyal customers.
However, that could be a lengthy procedure. If you’re looking for an easy method to improve your acquisition process and costs, you can partner with a growth marketing company like GrowthHit.
The company consists of a team that works with companies belonging to several industries, including eCommerce, lead generation, real estate, financial services, beauty, fashion, health care, fitness, SaaS, and education clients.
The experts design a customized growth plan based on your company’s target audience and business plan.
Once customized, the team runs several growth experiments, such as website development and design, Facebook and Instagram ads, Conversion Rate Optimization (CRO), email marketing, ad copywriting, etc. All these efforts help businesses become scalable and achieve impeccable growth.
Connect with GrowthHit now and learn more about yielding your desired growth ROI.
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